Yum China Holdings, Inc. Q2 2021 Earnings Conference Call July 28, 2021 8:00 PM ET
- Joey Wat – CEO
- Andy Yeung – CFO
Conference Call Participants
- Michelle Cheng – Goldman Sachs
- Xiaopo Wei – Citi
- Chen Luo – Bank of America
- Anne Ling – Jefferies
- Lillian Lou – Morgan Stanley
- Christine Peng – UBS
Good day and thank you for standing by. Welcome to the Yum China’s Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]
I would now like to hand the conference over to your first speaker today, Ms. Michelle [indiscernible]. Thank you. Please go ahead.
Unidentified Company Representative
Thank you, Sabrina. Hello, everyone, and thank you for joining Yum China’s second quarter 2021 earnings conference call. Joining us on today’s call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung.
Before we get started, I’d like to remind you that our earnings call and investor presentation contains forward-looking statements, which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our filings with the SEC.
This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of the non-GAAP and GAAP measures is included in our earnings release.
Today’s call includes three sections. Joey will provide an update regarding recent development in our second quarter 2021 results. Andy will then cover the financial performance in greater detail. Finally, we will open the call to questions. You can find the webcast of this call and a PowerPoint presentation, which contains operational and financial information for the quarter on our IR website.
Now, I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?
Thank you, Michelle. Hello, everyone, and thank you for joining us today. Our business has recovered remarkably well. Although the pandemic is still impacting our business and will continue to do so, we have learned to live with it and we are focusing on the future. We focus on our core, good food, great value, and customer experience. We penetrate further into lower tier cities, we increase our store network density to shift to off-premise dining post-pandemic.
KFC remains resilient and continue to grow at a very fast pace. Pizza Hut achieved stellar performance and expect to become another growth engine of Yum China. [indiscernible] are making good progress.
We delivered a solid second quarter. System sales grew 14%, operating profits grew 83%. We expand the store footprint at accelerated pace, opening 404 new stores in the quarter. In less than one year, we add more than 1,000 net new stores and increased total store count to over 11,000.
Our team is laser-focused on driving sales. Our powerful digital platform enable us to swiftly adjust our marketing campaigns. We can reach members directly with targeted offers. In the quarter, we recruit over 10 million new members, ending the quarter with over 330 million members.
Notably, off-premise and home consumption are becoming more popular in a post-pandemic era. Our delivery sales grew over 60% compared to 2019. We also launched retail products across our brands, leveraging our online and offline assets. We intend to learn and innovate to address evolving consumer needs.
Let me update you on our core brands. First, let’s start with KFC. KFC led our new store opening. We increased store density in existing cities and entered over 100 new cities in the last 12 months. With 280 new stores opened in a quarter, we now have over 7,600 stores across China. More impressively, new store cash payback and profitability remained very healthy across city tier.
System sales grew 14%, led by same-store sales growth and accelerated new store opening. KFC successfully navigated this tough operating environment with reduced volume at transportation and tourist locations. Our operating profit grew by 50% to $240 million. It goes without saying the crucial role good food plays in our business.
In a second quarter, KFC add Wagyu and Angus Beef Burgers to the permanent menu. KFC also launched [Foreign Language] meaty chicken sandwich, as less limited time offer. These innovations generated strong social buzz and are well-received by consumers.
We know our consumers well and cater to local taste buds. KFC has introduced regional menu items such as Hot Dry Noodles, or [Foreign Language] and steamed dumplings [Foreign Language]. We also launched a sweet and spicy plant-based beef wrap and oats milk latte to provide more choices to consumers.
With our good food, we also offered great value. Throughout the quarter, we launched attractive promotions to drive traffic. Our main Labor Day holiday bucket, the first ever mix and match buckets for dine-in locations.
On the digital front, we focus on growing our member base and driving their spending. We launched a new privilege subscription plan, giving our members the choice of perks from a range of offerings. This provide visibility for our members and drive incremental sales. We sold 8 million privilege memberships in the quarter. So, every spending of our privilege members doubled that of regular members.
Now, let’s move on to Pizza Hut. Our transformative initiatives in the last four years have yielded great results. Compared to pre-COVID levels in the — to 2019, same-store sales continue to recover. System sales of growth turned positive, operating profit more than double from the same period last year. We accelerate our new opening and add 17 net new build in the first half of this year. This is the highest total new units we add in the first half since 2016. It shows our confidence in the business model now.
Happens — and other small store formats have proven to be successful and now account for most of our new stores. Store economics continue to improve. New store paper remains healthy. in particularly, for the hub and small store. We will continue to increase density and penetrate into more new cities.
In March new menu, we change 40% of the menu items compared to the previous year. In the second quarter, we continue to improve our product offerings for better customer experience. In June, we upgrade our hand toss dough with more premium flour and low temperature long fermentation. This makes the pizza dough crispy outside and soft inside. It tastes particularly good and very, very suitable for delivery.
We also launched [Foreign Language] steak with Parmesan cheese and knife-slice noodles. Not a very proper translation, but the Chinese name is called [Foreign Language] is a traditional specialty noodle of Shanxi province. This is a great fusion product combining elements of east and west.
To enable value proposition and enhance our value proposition, Pizza Hut has expand the price range of its pizza offerings. In June, we launched 13 new pizza of flavors at a more affordable price point, mainly for the new [Foreign Language].
We also launched another successful All You Can Eat campaign offering abundant value. The Pizza Hut membership reached a significant milestone of 100 million members. Members sales now account for over half of system sales.
Digital and technology continues to play an important role in driving sales. Digital ordering increased to 84% of sales from just 29% two years ago. Delivery and tableside mobile ordering became more popular.
Coffee, our coffee business is making good progress. Lavazza tripled its store count, although the base is a bit small in the second quarter. Initial results of a new store opening are encouraging. We now have 14 Lavazza stores in Shanghai and we are opening our first beautiful store in [indiscernible], which is the first store outside China in about one hour today.
We are confident in the potential of this 126 years old Italian coffee brand. Coffee enjoyed doubled its per unit sales compared to 2019 and has a meaningful number of stores breaking even at the end of the quarter. We are reinforcing its specialty coffee brand positioning, expanding day-part with more food choices, [indiscernible] the customer base, and have better value for money.
To conclude my session, we are well-positioned to capture the market opportunities in China. Our store network is growing at an unprecedented pace. We are investing ahead to fortify and future-proof our infrastructure and digitization. At Yum China, we are committed and confident to achieving sustainable growth in the many years to come.
With that, I’ll turn the call over to Andy. Andy?
Thank you, Joey and hello everyone. Let me now provide additional details on our second quarter financials and then share our perspective on this year’s outlook. Unless noted otherwise, all percentage changes before the effects of foreign exchange.
Let me first cover our second quarter financial results. Total revenue grew 17% year-over-year and reached $2.45 billion. System sales increased 14% led by same-stores sales growth of 5% and accelerated new unit development.
Similar to last quarter, we are providing pro forma measures here for convenient comparison with 2019. Same-store sales recovered to approximately 94% of the second quarter 2019. System sales grew roughly 9%, benefiting from new unit and the consolidation of Huang Ji Huang.
Sales were recovering in April and May, but this was actually was disrupted by the Delta varmint outbreak in Guangdong Province, at the end of May. Guangdong province is the largest economy in China and one of the largest market, housing two of the four Tier 1 cities. The outbreak led to temporary closures in the regions and affected consumer behavior across China. Same-store dine-in volume is still well below 2019 level, while off-premise occasions continue to grow rapidly.
KFC remained resilient and delivered robust growth. On a year-over-year basis, system sales of KFC grew 14% led by strong unit growth and same-store sales growth.
On a two-year basis, system sales grew an impressive 7% is at 2% faster than the Chinese restaurant industry growth of 5%. Despite suppressed traffic as transportation and food location, same-store sales recovered to approximately 93% with the same-store traffic at approximately 86%. Average ticket grew roughly 8% versus us 2019, mainly due to the increase in delivery mix.
Pizza Hut delivered exceptional performance. On a year-over-year basis, system sales grew 16%, same-store sales grew 11%. On a two-year basis, system sales growth in the quarter returned to positive.
Same-store sales recovered to approximately 97%, a two-point sequential improvement from the first quarter 2021. It was led by a 9% increase in traffic, driven mainly by more delivery and breakfast sales.
Restaurant margin was 15.8%, up 210 basis points compared to last year. This was mainly driven by sales leverage, favorable commodity prices, and operational excellence.
Cost of sales was 30.7%, 220 basis points lower than last year. Commodity prices declined by 7% year-over-year, mainly helped by lower purchase prices. Cost of labor was 24.2%, 150 basis point higher than last year. This was mostly due to lapping of COVID-related government subsidies we see in 2020 and cause — waging inflations of 3%. Labor productivity and labor shortage partially offset the increase.
Occupancy and other was 29.3%, 140 basis points lower than last year, mainly attributable to sales leverage savings in operating cost. G&A expenditure increased 10% year-over-year, mainly due to high compensation costs, consolidation of Pseudo-KFC and the resumption of some business travel.
Operating profits grew to $233 million, a 65% increase year-over-year, or a 6% increase compared to 2019. The increase was mainly driven by system sales growth and restaurant margin improvement. Our effective tax rate of 24.8% is similar to last year. We expect full year effective tax rate to be 27% to 29%.
Net income was $181 million. Adjusted net income was $185 million. Excluding $5 million net investment gains, it was $180 million, up 55% year-over-year. Diluted EPS increased to $0.42 from $0.34 a year ago, despite nudging our share base by roughly 1% as part of our secondary listing in Hong Kong last year.
Now, let’s turn our attention to the outlook. As we continue to drive sales growth and accelerate store network expansion, we need to mindful of the near-term challenges. It may sound like a cliché, but we continue to expect the impact of COVID-19 to linger and that there would be periodic regional outbreak.
So, full recovery of same-store sales to pre-COVID level will take time. Sales recovery will continue to be uneven and non-linear, impacted by a few factors. One, subdue traffic, transportations, and two is location.
Two, some health measures and restrictions on mobility to remain in place that will continue to impact dine-in traffic. Three, shop and school holidays.
Operating profits and margins have improved year-on-year in the first half, benefiting from sales leverage, favorable commodity prices, moderate wage increase, and labor productivity improvement.
We expect certain tailwind to turn into perhaps headwind in the second half. First, cost of sales, which will be pressured by our focus on value campaigns and increasing costs commodity prices.
We have already seen an uptick in purchase prices and we lapped the low prices in the prior year. Therefore, the commodity prices will potentially turn into inflationary pressure later this year.
Second, cost of labor. Cost of labor will increase in the second half of 2021 for two reasons. First, most of our store have increased restaurant staff wages in June and July. Therefore wage increase will be higher in the second half compared to 3% in the first half.
Second, we are also increasing staffing levels to ensure customer services. As a reminder, the speedy recovery last year creates a public comparison in the second half of this year.
ow, despite these challenges, we remain confident in our long-term potential of China. We’re accelerating store network expansion with increased store density to capture market opportunity and to better serve the shifting demand to all premise.
We now expect to open around 1,300 new stores in 2021. We also will incubate our emerging brand for future growth. To support this growth, we will continue to invest ahead in technology and infrastructure to further solidify our competitive position. We now expect full year capital expenditure of approximately $700 million to $800 million.
As we said about investments, restaurant margins as well, SG&A will reflect higher depreciation cost.
Finally, following an assessment of the COVID situation, our financial position, the Board has approved the resumption of share repurchases. There’s over $690 million remaining under the current authorization. We’re committed to drive long-term returns for our shareholders.
With that, I will pass you back to Michelle to start the Q&A. Michelle?
Unidentified Company Representative
Thank you, Andy. We will now open the call for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time.
Sabrina, please start Q&A.
Our first question comes from the line of Michelle Cheng from Goldman Sachs. Please ask your question.
Hi, Joey, Andy. Congrats for the very good result again during this environment. My question is about the labor costs and also the new guidelines on government to protect delivery riders are introduced. So, we all understand that YUMC has been taking care of the employees, but still want to hear management’s thoughts on the future labor cost management? And more specifically, given we have high revenue contribution from delivery business, so how should we think about the delivery cost increase due to government’s requirement? And also since we are also talking about the Delivery 3.0 to enhance the efficiency, so like can we expect some efficiency outside to offset this potential cost increase? Thank you.
Hi, Michelle, this is Andy, let’s — let me first give you some color on the cost of labor. As we have mentioned in prior quarters, we were facing labor shortage in some of our restaurants. And then we also have saw moderate in our wage increase over the past year, because pandemic situations. Now, we have decided early on in the second quarter to increase wages at our market, in the — for the restaurant staff.
And so as I mentioned on my prepared remark, we have increased wages in June and July in China. So, obviously, we rolled out, as I mentioned, over the two-month period across China. And so — and as a result, we do expect that duration increased will be higher and so — approximate 7%, which is going to be roughly normal to we’re returning to the pre-COVID level of wage increase. And so — as a result, as I mentioned, we should expect higher COL [ph] in the second half, because of the wage increase.
Now, of course, we — as a company, we always want to pay our staff more, high salary and high wages, we always follow that with focus on also maintaining profitability and delivering value for our shareholder.
Therefore, we have invested over the years and then we will continue to invest in technologies, improve our efficiency in operations, investment in automation, so that we can continue to drive that labor productivity improvement. So, hopefully, long one, we can continue to pay out our staff more, at the same time, maintain a reasonable profit margin for our business.
Thank you, Andy. Michelle, I’ve just — I have one comment about the labor costs and then I’ll address your question on rider labor law and Delivery 3.0. We increased our delivery sales mix from 11% right now over 30% since 2016, and I think you can see from our P&L statement that we manage to — manage the overall delivery rider costs and also to find a saving to fund and also to continue to deliver the profit margin for our shareholders. So, we have done it in the last five years as proven in the numbers and I believe that Andy also give you some idea about will continue to do that in the near future as well.
So, let me address the rider labor law question and Delivery 3.0. For the rider labor law question, I would like to make three comments. One is, we are compliant to applicable laws and regulations. And we also require our service provider to sign a Yum China Supplier Code of Conduct to ensure they are legally compliant with all applicable laws and regulations.
Second is regarding the right to safety, we have a very comprehensive delivery management system clear guidelines and we conduct regular audits to ensure food safety and rider safety. Of course, we also provide a rider training equipment with safety measures.
Third, very important. We actually work with our service provider to manage riders we’re intensity. Our riders, unlike other riders in the market, they’re dedicated to serve only Yum China brands, so, KFC, Pizza Hut, and we focus on surface quality. And one thing rather different which we have been criticized in the past, but now, I think we can see the beauty of it is our order density for rider is roughly 30% lower than the platforms. So, you ask the question, so how do we make sure we pay the rider well so that we can keep them? Well, we pay our riders more per transaction. They got paid a bit more money.
So, net-net, the pay — the take-home pay for the rider is competitive. On top of that, our riders enjoy stable income with less stressful work that intensity. In a short-term, it might sound like a disadvantage to our course, but remember, as I mentioned earlier, we manage the cost okay. But that’s absolutely right thing to do for the long-term with happier riders, better service quality, and protect our brand in the long-term.
So, let me move on to your question about Delivery 3.0. We upgrade our rider perform in 2020 to optimize our delivery trade zone and rider routing. As of right now, this platform covers 75% of KFC store and by the end of 2021, we will complete the roll off for all the KFC stores at the same time. At the same time, we are on top of we share the ride within few stores — few KFC store within a trade zone, we are also trying and going through the testing phase to share the rider with Pizza Hut as well.
So, all these work will continue in 2021. We do express the improvement in the trade zone optimization, the routing will result in improvement improving rider course. Of course there are more to be done as delivery business continues to grow. But the progress is good. Thank you, Michelle.
Thank you, Joey. That is very clear.
Our next question comes from the line of Xiaopo Wei from Citi. Please ask your question.
Good morning, Joey and Andy. Can you hear me? Yes, I will go ahead.
Yes Xiaopo. Go ahead.
Thank you. My questions are on Pizza Hut. We are glad to see the strong recovery both in sales and margin in Pizza Hut. As we know that casual dining has been very difficult segment for years for everybody. And according to the public information, while few of your competitors actually did a very weak performance in kind of dine-in sector, but you guys really surprised the market on upside.
I know that Joey and team had done lot for the Pizza Hut of the puzzle four years of products, delivery, innovation, et cetera. What do you think is most important factors contributing to the surprise on the upside? And why it suddenly take off and how long this kind of recovery — strong recovery can be sustainable? Thank you.
Thank you, Xiaopo. Well, I would say no sudden recovery is really the hard word of last four year. But it’s hard to translate, but I think the Chinese way call [Foreign Language] is a good way to describe it. You work on it for over four years, day-by-day on all the key areas and then finally, we get to the inflection point that the results start to speak for itself.
Let me comment on the path so far we have taken, but also what is next? Well, I think it’s fair to say that our four-year revitalization programs have yield great result almost in all the key dimensions from same-store sales traffic, same-store sales, system sales, margin, operating profit, and right now, new store opening. They’re all trending to the right direction. I’m not going to repeat the numbers, which you all have it.
We — if you remember, when we started journey, we had a very bold goal to turn the same-store sales positive within 24 months. And we did with deliver that, returned the same-store traffic positive first, then same-store sales. And in terms of which particular — analytically, we like to say, there are few focus. In reality, when we come to turn around business, I have to be honest, that we have to work on all areas. There’s no such luxury of just focused on one or two sector.
And we roughly categorized them into four pillars, the fundamentals, delivery, digital, and store format, which you guys should be more than familiar is not bored with the with the repeat focus. So, all of them, all of them have devilized. If I really, really impressed to single out one or two, I will have to say is the great food with great value, as simple as that. Food right now is fantastic, with great value for money. I my reason favorite chicken curry, curry vegetables, it’s hard to imagine that, but that’s national dish for British people.
And then the pizza has improved a lot, not only that topping, but — right now as of now, we’re having pizza topping with [indiscernible], that’s the abalone sauce with [indiscernible] and that’s Michelin star recipe. But the price is very, very good. So, there has to be a key attraction and turnaround. On top of that we have really worked hard to improve the technology, the digital ordering, and then the delivery, et cetera.
So, I’m not going to go through all the detail about the four pillar. What I would like to comment is what’s next? Well, we now have confidence in in the Pizza Hut business. And we are very clear that we want to make it another solid growth engine. What is next? Well, you guys are familiar with the to the next is resilience and high growth. We want Pizza Hut business as resilient as KFC business, so that it makes money during good time, but it also make money during bad time. That’s the best way to protect the jobs of our staff in this big market.
And also now we have good food, good value for money, but we also have found a away with the new store opening has industry leading cash payback and in-store profitability that’s even comparable to that of KFC, what a fantastic thing to have, particularly for the centralized store and new store — and small store. Therefore, you can expect we are going to pursue high growth for these very profitable store to pursue profitable growth now and in the future. So, focus on four pillars in the last four years, going forward, we’re going to focus on resilience and growth in particularly, profitable growth. Thank you, Xiaopo.
Thank you, Joey.
Our next question comes from the line of Chen Luo from Bank of America. Please ask your question.
Hi, Joey and Andy. Again, congratulations on another strong set of results. I also have some follow-up questions on Pizza Hut. I noticed in the announcement, Joey described Pizza Hut as another growth engine. We have not seen this level of confidence on Pizza Hut in the past few years.
And just now Joey also elaborate on a lot of initiatives regarding Pizza Hut. And in particular, I noticed Joey mentioned that for those satellite stores, the payback could be similar to that of KFC. So, can you actually elaborate on the unit economics of those satellite stores?
And also among the 1,300 store addition target this year, can we offer a rough breakdown between our brands such as KFC, Pizza Hut, and other brands? And also, lastly, in terms of margins, is it fair to say that we can — our medium term normalized restaurant margin for Pizza Hut could possibly return to the level that we saw during the years of 2017 or 2018 before we started to turn around the Pizza Hut business? Thank you.
Thank you. I’ll comment on the Pizza Hut comment and then the payback for the stores and then Andy will address the other two questions that you asked. I hope you can see our increasing confidence on our business on our Pizza Hut business in the last four years. But we did take a prudent approach and is very clear what are the steps that we have taken tried it first, and then sales, and then profit.
And when we get to the point that we can get all three, then we will grow more. It’s just like as I mentioned in previous earning calls, sales is vanity, profit is sanity, and we like both sales and profits. What is even better is even more profit, right? So, that’s the growth that come in.
The confidence of the Pizza Hut business model it does not come from one or two quarter positive results, it comes from the fact that we have been working very hard on improving fundamentals of the business. So, the pain of working on the fundamental is good thing, thus take time. And the joy of the fundamental improvement is the benefit is long-lasting. It will it will help our business model for the many years to come.
It’s not because of one-off promotion or et cetera, it’s because the improvement in food, value for money, store, look and feel. I mean the majority of our stores is very, very nice looking right now. I mean unfortunately you guys cannot see because you — it’s very difficult for you guys to come from — to travel from Hong Kong and China. I really look forward for your visit to our new stores, might be a bit too feminine for gentlemen, but it’s okay. We care about the ladies because they make the critical purchasing decision most of the time.
So, the improvements at all fronts and technology and now the customer like — and last year, the challenge on COVID-19 further challenge of business model. And we took the challenges positively and with great results. To give you an example, last year with the big impact on our dine-in business, our Pizza Hut business took opportunity to make the virtual out of necessity to use our existing ingredients to make very high value foods such as one person meal e-lunch, and that right now is bringing in incremental sales because our party-size traditionally has been big, but the one-person meal is incremental business to Pizza Hut. And also because of the pandemic, we push ourselves to grow the new retail business not only we deliver cooked steak, but we also sell raw steak, marinated some raw steak that yourself or your IE cannot destroy.
So all these are the result of hard work in the last full year and particularly last year. And therefore, we are at a point that we can be very responsible with our view that we believe Pizza Hut is another growth engine, given the size of the store, right? We have over 2,400 stores of Pizza Hut and in over 500 cities with fantastic brands, particularly in casual dining business.
So that’s the fundamental. And for the payback for the small store, particular Hub & Spoke store, which is the business model I introduce to our shareholder, investor back to 2019 March. So much lower investment. It really supplement our current Pizza Hut store density. It also helps to make our current Pizza Hut store which are not too small, make a real asset, because the original stores will be what we call mother store. These are the big store, and they will be helping to open the tier store, which is the satellite store to provide better convenience to our customers, focusing on off-premise consumption. So now the satellite store, together with our original casual dining store, it’s fantastic network, it’s a great way to grow our business.
It’s not like we have to go to — we go very far away. And we just put in one satellite store and logistically it’s very difficult? No. We have stores there already. We have the potential dine-in stores there already, we’re just going to increase the density of our stores that to help the delivery of off-premise business.
And when I say the cash payback is good at comparable to KFC and our numbers show that the success rate is very high because the investment is very low. And the payback is about two years. So that’s fantastic.
Okay. So — hi. Let me address the question about the 1,300 new build that we’re looking at for this year. I think if you look at the breakdown, I think would obviously somewhat similar to before, mainly KFC is a very strong, powerful machines. It continued to generate very strong cash payback. So, we should continue to expect variable as well for KFC and it is going to continue to be the lion share of the new store build.
As Joey mentioned, like, we continue to gain confidence in the economics for Pizza Hut. And then especially for the satellite store and a smaller store format. So you should see some accelerations on Pizza Hut’s new store opening in the second half as well.
We also — as you heard and Joey have mentioned on her prepared remarks, we’re seeing obviously very strong with customer reception for Lavazza. We triple in our store count, almost triple from about five-store to 14-store in the second quarter. So, I mean, we also have a number of stores in the pipeline, so you should also expect Lavazza coffee business to be a driver.
And then this [indiscernible] the Chinese cuisine business, hot dry business. Also, we’ll see a uptake in store opening in the second half. So, that’s generally the competition of the 1,300 stores. But again, like, I will mention that usually the store opening will be probably faster in the second half — in the latter part of the year. So, that’s generally the trend before the Chinese New Year. And so it is not completely linear, but that generally users see some acceleration in the store growth for new store opening.
Now in top Pizza Hut margin, I think we’re very pleased with Pizza Hut improvement. As Joey mentioned, not only it grew very strongly on SSG, our system growth, monitoring on traffic. And then so the biggest driver, obviously for margin improvement is sales leverage. And so the other part is for — and also labor productivity in the store and in a model. And so if you look at the first half though, we did benefited from, as I mentioned two factors. One, low commodity prices, right? And two, we have store like, more moderate labor costs increase that have improve the margins in the first half.
Now, in the second half, I think, similar to KFC and Pizza Hut, we have grown our wage increase across China in June and July for our restaurant staff. And so you should then — and also we’d likely to increase hiring as well, and so you should expect a increase in labor cost there. And then the enterprise that we also think commodity prices will be a less favorable, and it’s very favorable in the first half, commodity prices down 7% year-over-year. So, and I think we have seen, for example, poultry prices, like which is low in first quarter, and then have been rising since. And so, we do expect that commodity prices also would build some pressure there. And then perhaps turn into a inflationary pressure up here.
But those are the long-term headwinds that we face. But I think for Pizza Hut, we have continue to drive, I think the value for them, obviously, still to drive traffic, drive sales back to store. We’re still at a recovery phase for the pandemic or the number one thing for them, obviously, continue to focus on making sure that customer would come back to the store, come back to then increase spending, and then we will continue to drive that possibly improvement as business returns.
And then we will also look into driving that long-term profit improvement of the Pizza Hut, but that should be a longer-term point of view. It shouldn’t be getting as immediately to drive to squeeze profit.
So in terms of the news economics, I think a couple things right away, one is that a small — the store are generally smaller is that what I saw is more so as the name would imply. So the throughput first off of our new store probably lower than — existing portfolio. However, the profit margin is good. And then we have lower our upper investments. So the overall return is very strong. And as Joey mentioned or how I saw is almost comparable to what KFC can do. So, that’s very economic term. So hopefully that — with that we addressed your question. Thank you.
Yes. Thank you Joey and Andy. This is really helpful.
Our next question comes from the line of Anne Ling from Jefferies. Please ask your question.
Hey, thank you very much. Most of my questions been answered. But just one follow-up questions on the cost side. Andy you mentioned about the cost increase for commodity as well as labor. In the past you share with us that in terms of quantified it like for example, in the beginning of the year 2021 you mentioned about labor costs increased by mid-single-digit. Now we’re in the second half, maybe I’ve missed it, but would you share with us that the cost increase for commodity labor costs as well as SG&A? And also may be a breakdown in terms of the CapEx for the $700 million to $800 million CapEx which is the revised number. Thanks.
Okay. Hi, Anne.
So, let me address the first question about commodity price and wage increase. Commodity prices I think if you look at the first half we benefited from the lower commodity prices by almost 7% year-over-year. As I mentioned we have seen commodity prices, especially poultry prices have — which is, I guess, the recent low in the first quarter and have been rising. And then so, we’re going to see less benefit, much less benefit of the lower commodity prices in the third quarter compared to the first half.
Now, we — obviously the commodity prices is very hard to predict, but current trends suggest that based on a contract prices and whatnot, such as that maybe perhaps in metal price this year, the commodity prices could transform a favorable 7%, year-over-year, deflation pressure to a inflationary pressure, right. So that’s our near-term outlook for commodity prices.
Now, in current labor costs. In the first half, our wage increase was about — wage cost compared to last year was about 3% increase. As I mentioned, we have decided to adjust how much on staff wage and so we have will that wage increases in June and July, and that is about possibly 7% year-over-year increase there. So that’s second part of that. And then the third part, I think for the cost of labor is twofold. One is that, obviously delivery due to the higher mix of that. And then if you look at the hiring, I think we also have mentioned over the past two quarter that there’s some labor shortage and hopefully with the salary and wage increase over there will ease that situation as well. So we’re going to increase hiring.
Now, obviously, as Joey mentioned, we continue to look for savings to pay for that, and then we’ll continue to do so in second half to look at productivity improvement, how we can better utilize our IT technologies to help that. And then as Joey also mentioned, we continue to try to improve our delivery operation as well and drive efficiency. So — but that’s a short term outlook for us in terms of both COS and COs out.
Now, the second question is about the $700 million to $800 million CapEx for this year. I think obviously, the lion share of that is going to be in new store, new view and then the second part is going to be for remodeling. Remodeling continues to be important part of our tax program. We want to keep our restaurants fresh. And so we genuinely have a pretty robust remodeling program and then there was obviously investment in our IT and infrastructure. And then those are the main categories of our spending roughly in third quarter. And then in terms of what was the…
Oh, G&A expense. G&A. Yeah. So, obviously, on a year-over-year basis, G&A one, is we will have less carbon-related substance, this last year, as you remember, there was general reductions in the security insurance payment for works here in China and so that has expired. The other part is that obviously, we also have modern salary and wage increase, compensation increase for above that.
Third one and at the same point hope folks don’t forget is that last year, we have two acquisitions, one is the consolidations of our Suzhou operation, the other one is the acquisition of Huang Ji Huang both of them would absorb that G&A expenses. And then finally — and then last year because of the pandemic, we basically would have stop almost all the business travel, and with the improvement in the situations, there will be some return to some, not all, but like some return to some business travel. I think that’s normal path. And hopefully that gives you some ideas about the expense and cost environment that we’re facing right now.
Thank you, Andy.
Thank you. Our next question comes from the line of Lillian Lou from Morgan Stanley. Please ask your question.
Thanks, Joey and Andy, for the very detailed explanation, I have a question on the new store expansion because I think so far, you’ve been doing a very good job in terms of managing both very fast store expansion and margin improvement. So I just want to understand more in detail about the increase of store density impact to the existing stores, does that have any impact on the same store sales growth of the existing stores? That’s one side. And the other side is yes, the payback and return of new store are quite good. So, how are we going to look in the future with continued store increase, especially we uplifted the target again, what kind of a dynamic we should look at in terms of the new store margin and also the impact to the existing stores? Thank you
Hi, Lillian. Well, thank you for your questions. Obviously, we are very pleased with the pace of store opening with that we continue to capture the market opportunities that is presents to us, especially in the lower tier cities, but also — and also allow us to better serve our existing market. And we have new designs as you mentioned, our store network in existing markets, so, that we can increase the density and better serve customers need for delivery and take away. So obviously, when you open a new store, especially increasing the density, it’s natural to see some sales transfer. New store opening, but that also — the impact is not the same everywhere. And today, if you look at SSG impact, I think the pandemic obviously is far most, the most important one right now.
The sales overall — SSGs sales overall is quite price sensitive to for example some of the regional outbreak, as we have seen in the first quarter, and as we have seen in June. And so, we have always asked analysts and investors to set up like pay attention to the region outbreak as we are. We don’t need to be overly alarmed by that, but we need to stay alert because our experience tell us that periodic region outbreak is to be expected. We have seen that in December or January. We have seen that in June in Guangdong. Now, we’re seeing a potential outbreak here in Nanjing and that is still solid situations.
So, well driving SSG, there’s many impacts, many, many different factors there. But again, like going back to the main point here, which is some. So for more tier cities, there will be some impact, but if you look at lower tier cities overall, the SSG focus is actually faster, right. And for some of urban area, I think as we design our network, one thing that will impact SSG is to reduce that delivery trayzell. So for example, if you have a store that was five kilometer before, now, you are going to shrink it to three kilometer, because you want to have better delivery services, and whatnot. And so that would naturally, with that increased density, we are able to cover that — we’re able to do that to serve our customer better. But that would naturally means that we will have to shrink some of the retracement or [Indiscernible] [58:58].
So — but I think would that have like impact on SSG? Probably a little bit, but it’s not the right thing to do. Absolutely. And especially when we look at some of these changes that have been accelerated by COVID-19, one of them stand out is obviously delivery sales, right off-premise consumption or at home consumption. So this is something that, I think when we mentioned the store opening and SSG I think there’s something that needs to be to be aware of. The other one is what’s the other one here, payback in the future was increased target.
Will increase store target.
Store target. So, if you look at our store opening, we always have a very disciplined process. And there have been so for as many years and then this continue to be so and will continue being in the future. That’s why when Joey mentioned, we’re going to try to accelerate growth, she put a special emphasis on possible growth.
And so, you know, and then if you look at, our payback period, for both KFC and the Pizza Hut, they will have been very robust and very stable for KFC roughly two years, and for Pizza Hut roughly three to four years. And as to imagine, for some of the smaller store, and, and it’s our lifestyle nowadays. The payback period could be even shorter than that. And so, we will continue to do that maintain a balance between, faster growth, to capture market opportunity to better serve our customer, but also maintain, our financial discipline for profitable.
Thank you, Andy. The only thing, I just want to add three colors to — three highlight to your question. First of all, we would really like to — our focus on system sales growth in the short term and long term. Because this is not a mature market, yet, there’s still a developing market with huge opportunity to open new stores. We are only in 1,600 cities in China, and there are still few 100 cities for KFC and there is 1,000 cities or for Pizza Hut.
So let’s look at the systems in the short term and long term. Our margin, we always have the balance on the profitable margin growth. And I would like to add three things. One is, in the past few years, both KFC and Pizza Hut, particularly KFC we have made ourselves very flexible. And that flexibility is part of resilience for us to open store — to open more store within the gap of existing stores and to open more stores in the new cities. I’ll give you a few drivers here Andy mentioned, and I would just like to touch upon it.
Well, the time travel is the field right now, it probably would stay. We see that therefore what are we doing? We try to grow incremental growth from the data. You know, for example, late night [Foreign Language] is the chicken bone from [Foreign Language]. You know, it’s fantastic new product innovation that really drive the sales of the late night. Is it enough to feel the tab of the diet? No. But you know, for now, is — the dining business is challenging probably will stay but we see the opportunity for incremental business.
We also see the opportunity regional menu which we did not — we have no you know, further is broad opportunity. With sample you know, the Wuhan lasagna is not only selling well in Wuhan, its selling even better in Jiaxing and San Juan because for Wuhan people Jiaxing and San Juan KFC is the only place that they can buy the hot fry noodle. So and we also start the new retail that’s across all the brands, that is fantastic incremental business to delivery business as well as off premise business.
So that’s internal, internally we become a GM right, internally we become more flexible, stronger, that allow us to take advantage of more store locations to open more stores. Well, secondly, we have become a better tenant. If you think about last year, what happened is we are one of the very few retailer food retailer that can continue to pay rent, and we did not lay off any people. Tenant, whether you’re good to know no is decided by the landlord and the landlord now really like us, if not lumber particularly in the lower tier city. We are clear traffic driver and anchor tenant and the rent we are getting a lower tier city is fantastic.
And that helped the economics of the new store opening. And now we also have become more clear with our new franchise strategy, the channel franchise strategy, the remote area franchise strategy, so that we are helping our franchisee to open more stores in the area that we can still do it, but it is not as efficient as for the franchisee to run the operation locally in the remote area.
So with the, three combine factors, we believe that we can continue to pursue a system, sales, which is a combination of profitable new store opening, and the recovery of SSG, and then also protect the margin because it will not be right for our shareholder in a short term in the long term. If we buy market share, we don’t is the discipline. We only pursue profitable new store growth with industry leading cash payback and install profitability. Thank you, Lillian.
Thank you, Lillian.
Thank you. Thanks a lot, Joey and Andy.
Go ahead, operator.
Please go ahead.
And again, our last question comes from the line of Christine Peng from UBS. Please ask your question.
Thank you, Joey and Andy to share so many colors on your company’s latest operations as well as management source towards many questions investors have been asking the analysts about. So I have a question regarding the coffee business. I think Joey, you mentioned briefly about the latest operations about Lavazza coffee and enjoy. I remember when I was in China, end of last year I visited the store of Lavazza office.
And when I look at some of the commentary on the social media platform, I realized there have been a lot of changes to Lavazza newly operated stores in China compare with one I visited end of last year. So Joey, maybe can you share with us more colors about the latest progress you’re making to Lavazza, especially how you think about long term positioning of the brand compare with existing competitors such as Starbucks, and if you can share with us some of the financial details such as store economics, they’ll be even more appreciated. Thank you.
Thank you, Christine. I hope one day you got it. You can try our [Foreign Language] and see whether you like it as a as a local person. Competitor cost EBITDA, we let’s take a step back. We have three coffee brands in young China, cake, coffee, C&J and Nevada. I’ll come to Lavazza. But I am very happy to report play coffee for 2021 first half, we increase the sales of coffee per cup by as much as 30% compared to the pre-pandemic 2019 number.
And that shows that our focus on good coffee affordable price is a viable strategy is before the coffee business. C&J, we have been working on it now we have 30 a store. And we’ve been very transparent that we are learning the operation side of a business of a new business, we have huge respect towards new business. And I’m happy to report that we are there because, you know, a meaningful number of though we’ll be breaking even by the end of this quarter and more will be by end of year end.
And that allow us to build the people. Business is about people without good people, there’s no business. So we build our operation people and we become sharper with our marketing positioning and pricing etc. And these learning are all helpful very helpful. When it comes to the experience of building Lavazza brand in China, it takes much less time compared to CNJ for us to get the operation right to get the marketing right and also with our fantastic partner Lavazza help to get the foot right together Italian flavor of the whole environment, the food, the drain, et cetera.
So, Lavazza Andy said earlier, I’m going to emphasize we are going to have a stellar rate of pace of development for the second half of the year compared to the first half. So first half, we move from five stores to today 15 stores, mainly in Shanghai and now one store in Hangzhou. So for the second half, we have we a salary, there’s no opening pays, and we’ll enter into more cities in China. So that’s in terms of footprint. In terms of business model Right now, we so far have in Shanghai for the 14 store, we have half of the store what I call — what we call large store to build a brand.
And then the other half are either smaller, slightly smaller store or meanings though, these are the stores with much better economics to make the money faster. So a combination of flagship store to build a brand and then smaller store to build ourselves. That seems the right thing to do. And we are very happy with the initial result. So that’s the second.
Third is we already are encouraged by the initial result and working on a PayPal, menu, combo delivery, and others. Our off premise sales mix right now is over 50% for all of our stores. And that’s good, right? Because we know that right now the off premise is the is the trend. And for Lavazza, obviously Finally, my comment is the position is premium is authentic Italian style coffee with a nice environment, we believe the Chinese consumer can have a choice, can have an alternative, other than one single choice in this beautiful, premium coffee segment.
So that’s where we are right now. And we cannot wait to see more beautiful store with fantastic, is that, I suppose is hard to get our Italian partner to produce bad Italian food. And we are not complaining about it. So we really look forward to have opportunity for our investor and for analysts to try our alabaster coffee in China. Thank you very much, Christine.Hopefully, in Hong Kong one day, by the way.
Unidentified Company Representative
Thank you, Christine. Before we end today’s call, please know that we will host a virtual investor day on the morning of September 23. Shanghai time, we will announce more details as we get closer to today. With that, we will conclude today’s call. Thank you for joining. Have a great day.
Thank you, everyone. Thank you, operator.
Thank you everyone.
This concludes today’s conference call. Thank you for participating. You may now disconnect.
Source: Yum China